Part one of this mini-series can be found here.

It’s has been only a week since I wrote the first part of this mini-series on Cliffs Natural Resources Inc (NYSE:CLF), but in this short space of time the company’s new management team has been busy.

Cliffs Natural Resources Logo

Cliffs Natural Resources management change

After Casablanca Capital, the activist hedge fund trying to instigate change at the company, gained control of the Cliffs Natural Resources Inc (NYSE:CLF)’s board at the AGM, Lourenco Goncalves, one of Casablanca’s candidates, was appointed chairman, president and CEO, effective immediately. Goncalves replaced Jim Kirsch and Gary Halverson who have served as Chairman and CEO since July 2013 and February 2014 respectively.

What’s more, within the same announcement it was revealed that the company was reversing the decision to idle the Pinnacle coal mine in West Virginia. The Pinnacle mine is one of Cliffs’ largest coal mines, employing 500 employees.

However, now Mr Goncalves and Casablanca are in control of Cliffs Natural Resources Inc (NYSE:CLF), there is some confusion as to what the next course of action will be. One thing that most parties agree on is that Cliffs’ future hinges on Bloom Lake. Some analysts have stated that the company will move quickly to close down the Bloom Lake mine, while Casablanca itself has stated that it wishes to keep the mine open, as covered in part one.

Cliffs Natural Resources’ Bloom Lake mine to become a money pit

It seems as if Cliffs Natural Resources really has little choice in the matter. Bloom Lake has costly take-or-pay agreements tied to its production. So, unless the company meets set production targets, the mine could become a money pit. It’s estimated that even a full shutdown of the project would incur costs of $275 million to $300 million per annum. This figure is slightly above the current estimated mine cash burn figure of $260 million per annum.

The other option is to throw yet more cash at Bloom Lake, in order to increase production and drop costs. During the second quarter Bloom Lake production hit a record level 2 million tons, at a cost of $94 per ton, including a $7 per ton lower-cost-or-market inventory adjustment. Excluding the adjustment, the production cost per ton would have been approximately $87 per ton.

Casablanca has previously stated that Cliffs Natural Resources Inc (NYSE:CLF) could sell Asian assets to fund Bloom Lake’s development, which is a viable option.

Nevertheless, now Casablanca is in charge there is hope for Cliffs Natural Resources. The company can sell off non-core unprofitable operations, such as Asia pacific or North American coal while concentrating on low-cost iron ore production. Liquidity is not an issue, the company recently extended its loan facilities and increased the headroom, so there is room to make adjustments. Asset sales should reduce debt which stands at around 50% of equity.

But the placing a value on Cliffs Natural Resources Inc (NYSE:CLF) and looking for a margin of safety is not going to be an exact science. For this reason, I would caution that Cliffs is a risky bet.

Cliffs Natural Resources’ financials

In terms of book value, Cliffs’ tangible net asset value stood at around $6.6 billion at the end of the second quarter, $43.11 per share. With so many assets on the chopping block this asset value could collapse over the next few quarters, as Casablanca seeks to shed any unwanted assets.

However, strip out the loss making assets, North American coal, Eastern Canadian iron ore, and Cliffs Natural Resources actually reported sales income of $342 million from its Asia Pacific and North American iron ore operations during the first half. SG&A and interest costs amounted to approximately $305 million for the period. This is where Cliffs can really drive value creation. If the company sells loss making assets to reduce debt and mining costs, the company, even in the current weak iron ore pricing environment, could be highly profitable.

So as a trade Cliffs Natural Resources could be an interesting bet as Casablanca enforces change.

Side note

For those looking on more information regarding the Cliffs Natural Resources Inc (NYSE:CLF) saga, the daily, ‘Stocks to Watch’ column by Barrons is an essential stream of information. Cliffs’ stream can be found here.